Option to Consider When Choosing to Rent to Own

Author Colleen Kane of CNBC published a great article a few years ago, but it is still so very relevant to today’s times when it comes to renting a property for the purpose of one day purchasing it. She explained that when the term “rent to own” pops up, it’s not always clear what it means, and that’s partially because renting to own and the similar plan lease/option can work numerous ways. However, in a typical scenario, tenants can rent for a set period, such as a year, then when that time is up, they have the option to purchase the home. A portion of the rent is often credited to the sales price or closing costs.

Furthermore, the article goes on to explain that, tenants may also purchase the option to buy the property for a predetermined price at the end of their lease by putting down a (non-refundable) payment of about 3 percent. With this option in place, the tenant is not bound to purchase at the end of the lease, but meanwhile, the property owner can’t sell to anyone else.

Plans like this can appeal to people with little or no savings for a down payment, or people with bad credit or no credit who don’t qualify for traditional mortgages. The latter group can include those who lost their homes in foreclosures, according to real estate investor Barb Getty, who has had both positive and negative experiences with rent-to-buy contracts.

“People don’t realize that renting to own is also a way to get into a desired neighborhood in a timely matter, as with parents who need to be in school district for their kids, or people who are uncertain of their timeline, according to San Francisco real estate professional Herman Chan.” Herman Chan said, “It’s a way to get into a house without committing to a 30 year mortgage,” he said. However, there are some stipulations that should be disclosed by the seller and understood by the buyer.

It’s not a very common practice. Of the 609,482 sales transactions on record in San Diego from 1990 to the present that were conducted with a real estate agent, only 782 were completed with a lease option contract, according to the San Diego Association of Realtors.

Let’s take a look at the pros and cons. For those doing the lease option rental, the primary benefit to the buyer is that or or she can lock in a price, according to Phil Georgiades, the chief loan steward for VA Home Loan Centers in California.

However, there are numerous concerns and potential drawbacks that make rent to buy more complicated and often more expensive than straight renting. Among them: the tenant’s rent payment will likely be higher than market rent as part of that will be going toward the eventual down payment on the property. This extra amount will be forfeited if the tenant doesn’t act on the option to buy.

The potential buyer may be responsible for paying any back taxes the current owner may have incurred, said Georgiades. Also, prospective home buyers will still need to have the home inspected, just as with a traditional home purchase.

Getty points out that if the renter/buyer can’t make payments anymore, that means foreclosure, not just eviction.

However, John Farrell, an Episcopal priest, had a positive experience transitioning from renter to buyer of his apartment at the Riverview Club in Yonkers, N.Y. Two years ago, when a heart attack forced him to retire, he signed a lease on an apartment with option to buy (there was no fee for the option), and after one year he purchased the apartment, putting 10 percent down. His first year of rent went toward lowering the purchase price about 5 percent — the equivalent of six months’ rent. “It was a can’t lose situation for me,” he said.

Other experts are not convinced. “Very rarely does it make sense to rent to own. It’s a complex process, [and] most people don’t understand what they’re getting themselves into,” said Denise Winston, financial expert and author of “Money Starts Here! Your Practical Guide to Survive and Thrive in Any Economy.” “If they had more discipline with their finances they could do this on their own without the risk of the market, without the risk of losing all the money if something defaults.”

“It is a complicated deal and very speculative,” echoes Melinda Estridge Long, a real estate broker in the Maryland-Washington, D.C., area. “I have gone down this path with a few clients and have found it to be a large risk for both buyer and seller, as both are required to agree on a price in the future — always a crap shoot,” she said. “It is almost better to do a rent with a possible option to buy when the time comes.”

For those who don’t have 20 percent down payment money lying around, Georgiades suggests some alternatives: there are low down payment options, and government home loan programs lending to people with bad credit or who have low income and little savings.

“The best option is boring, but tried and true,” said Brandon D. Smith, a senior analyst in Los Angeles. “If you’re renting, and can afford higher payments, don’t rent-to-own. Put the difference in an interest bearing account and build up your credit. Have a stable income. If you’re a first time home buyer, you only need 3 percent as a down payment. Then buy a house with a long term, low fixed rate loan. At some point you may be able to fool some sucker into renting to own from you.”